Rule 1 to Avoid Being An Average Investor
Rule one to avoid being an average or worse investor is to understand the only time you make or lose money on a investment is when you sell it. This seems obvious, but it is amazing to see how often investors look at an account statement and think how much they have made or loss depending if the statement shows a gain or loss. If it shows a gain they are happy but if it shows a decline, to many investors decide to sell turning a paper loss into a real one.
Why do below average investors do this?
I would suggest the primary reason is many investors make emotional decisions on non-emotional events. And they ignore history.
History 1 – Historically the stock market as measured by the S&P Index goes up much more than it goes down. From 1929 thru 2022 the stock market increased 63 calendar years and declined 30 calendar years.
History 2 – When the stock market has declined in the past it has eventually recovered and gone higher. From 1929 thru 2020 there were eight major declines and all were followed by recoveries and eventually new highs. [Note: Though the market has a gain year to date, it has yet to fully recover from the decline of 2022.]
History 3 – The stock market has been a significant creator of wealth for long-term investors. Since 1929 the stock market average annualized return has been about 9.5%. Ending in 2022, the past 5, 20 and 30 year time periods the average return has been about 7.5% which has been significantly higher than the inflation rate during those same time periods. [The 10-year return ending 2022 was higher at 10.4%.]
So again why do investors ignore years of history, panic and then sell. There is no historical reason for so doing. Its not informed or logical, but it is emotional. They review a performance statement, notice their investments [account] has declined since the last statement. Then going against common sense and historical data, decide they are losing money and turn a paper loss into a real one.
The reality is there are many factors are that can lead to this emotional response. One comment I heard from investors in 1987, 2002 and 2008 was “this time or different” or “it will not recover in my lifetime”. For the record each time it did recover and it did not take very long.
But of course as every disclaimer states, past performance does not predict or guarantee future results. This true. There are no future guarantees for the future. But when making long-term investment decisions, does it not make more sense to base those decisions on historical facts versus emotion.
Which brings us back to the beginning. When an investor sells during a decline the investor historically has turned a temporary paper loss into an actual loss. And that is one way you become a below average investor.